Hilsenrath's Big Scoop Confirms Just How Bad The Fed Is At Communicating

REUTERS/Gary Cameron

US equity markets had a bit of a Hilsenrally yesterday afternoon.

A Hilsenrally is when WSJ reporter Jon Hilsenrath reports something about how the Fed is leaning dovish (towards loose policy) and markets shoot up, because of the belief that Hilsenrath is expertly sourced within the Fed, and thus is word is basically the word of the Fed.

But if you actually look at the story, it's not only not that significant, it's almost worrisome.

Here's the nut:

Federal Reserve officials have been trying to convince investors for weeks not to overreact when the central bank starts pulling back on its $85 billion-per-month bond-buying program. An adjustment in the program won’t mean that it will end all at once, officials say, and even more importantly it won’t mean that the Fed is anywhere near raising short-term interest rates.

That bolded line was interpreted as just meaning the Fed isn't close to raising short-term interest rates, and that's what goosed the market.

But that was well known. The real point of the story is to convey that the Fed has a communications problem, because apparently some investors think there's a connection between pulling back on QE and raising rates.

The problem stems from the fact that the Fed is currently engaged in two forms of monetary stimulus.

The first is QE: Bond buying, which theoretically reduces yields, and injects liquidity into markets.

The second form of easing is communications-based. That's the "Evans Rule" which stipulates that there won't be any sort of rate increase at least until unemployment hits 6.5%.

The beauty of the second form of easing is that the communication angle is very clear. You know the Fed's targets, and the Fed doesn't have to say anything to make it clear.

But the QE part has always been a head scratcher. The Fed wants to see considerable improvement in the labor market, but nobody knows what that means. Is 150,000 new jobs per month enough required to begin tapering bond purchases? Is 175,000 enough? Nobody really knows.

And because people don't understand the communication of the QE part, the Fed is worried that a misunderstanding is bleeding into the rate rise Evan's Rule part, which is why this Hilsenrath article was necessary.

A prime Bernanke innovation has been the use of communication as a strong form of Fed easing. But there are still wrinkles that need to be ironed out. At the next Fed meeting watch for Bernanke to try fixing this.

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